Credit

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Credit Ratings

Written by Kimberly Clark

A credit rating is a formal assessment of a company or government entity's ability to repay its debts. The rating is typically assigned by a third-party credit rating agency, after a thorough review of the financial history of the organization requesting credit. In general, credit rating systems are used to evaluate the risks associated with investing in bonds issued by a particular company or government body.

A company or government that is in need of cash will often opt to sell bonds to the public. In return for their investment the entity promises to pay the investor regular interest payments until the bond matures. When the bond reaches full maturity the entity then repays the initial sum (principal) plus any remaining interest payments.

The Rating System

When deciding whether or not to invest in a bond, the two credit rating agencies whose risk analysis is most widely reviewed and then accepted is that of the Standard & Poor's Corporation and the Moody's Investor Service. According to these credit rating agencies, the higher the assigned rating the more likely the bond issuer is to make their scheduled payment.

Both Standard & Poor's and Moody's use "AAA" to denote their highest rating. Bonds with this rating are considered to be safe bets and secure investments, because they carry minimal risk. Companies and governments that receive high credit ratings are allowed to make lower interest payments, which means investors who purchase their bonds will realize a lower rate of return on their investments.